At the end of May, Bank of America caused a stir when it announced that another of its proprietary “guaranteed bear market” indicators created by the bank’s quant team had been tripped, bringing the total to 13, and up from 11 at the end of January.
Fast forward nearly half a year forward, when overnight Bank of America provided an update on its bear market checklist, noting that of the signposts that have occurred ahead of bear markets, 14 have been triggered (74%) at this point. Specifically, the VIX rose above 20, and a net 20% of responders in Conference Board’s Consumer Confidence Survey expect stocks to be higher, causing these two signposts to flip to positive. At the same time, another trigger was “switched off” as trailing 12 month S&P 500 total returns dropped below 11%.
As the bank further adds, going forward, factors to watch for are deteriorating credit conditions and improving investor sentiment, a contrarian indicator.
This is how Bank of America itself previously explained this particular creeping “very late cycle” indicator:
we compiled a list of bear market signposts that generally have occurred ahead of bear markets. No single indicator is perfect, and in this cycle, several will undoubtedly lag or not occur at all. But while single indicators may not be useful for market timing, they can be viewed as conservative preconditions for a bear market.
Today, 14 of 19 (74%) have been triggered, or in other words, we are now more than two-thirds of the way to the next crash/recession/depression. There is a (somewhat forced) silver lining:
While around 2/3 of them have triggered so far, 80% or more were triggered before previous market peaks
Which means that the tripping of just one more indicator would be a “guaranteed” trigger of Bank of America’s bear market signal.
Below is the full breakdown of bear-market signposts as of Sunday night:
While some have dismissed BofA’s bull/bear model as too rigid, empirical evidence shows that this particular indicator has been remarkably accurate in predicting not only the size of the upcoming drop (-12% on average) but also the timing. Also notable: its uncanny accuracy: it was correct on 11 out of 11 previous occasions after it was triggered.
Assuming the cycle peaks at 14 of 19 triggers, what does it mean for the timing of the next recession? According to BofA analysis, “history says we’ve got 21 months” to wit:
When a similar percentage of bear market signposts having been triggered in the past, it has taken 21 months on average for the market to peak. Four of the past seven bull markets have peaked with 100% of the indicators having been triggered.
Of course, if any of the outstanding indicators that have yet to “flip” are triggered, of which there are now five, to wit…
- Tightening credit conditions: Each of the last three bear markets has started when a net positive % of banks were tightening C&I lending standards
- Trailing S&P 500 12m returns: Minimum returns in the last 12m of a bull market have been 11%
- Sell side indicator: A contrarian measure of sell side equity optimism; sell signal trigged in the prior 6m
- FMS cash levels: A contrarian measure of buy side optimism
- Inverted yield curve: Doesn’t lead/catch every peak and of all inversions, all but one (1970) has coincided with a bear market within 24m
… then the timing of the next bear market will be brought forward progressively to just a few months. If and when all triggers are hit, a recession would be imminent.
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